Handout - Financial Planning and Budgeting PDF

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Discussion and Practice Problems on Financial Planning and Budgeting...

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FINANCIAL PLANNING AND BUDGET 3RD TERM AY 2019-2020 J.A. SIMBILLO OVERVIEW Time and money are scarce resources to all individuals and organizations; the efficient and effective use of these resources requires planning. Planning alone, however, is insufficient. Control is also necessary to ensure that plans actually are carried out. A budget is a tool that managers use to plan and control the use of scarce resources. A budget is a plan showing the company’s objectives and how management intends to acquire and use resources to attain those objectives. A budget: 1. shows management’s operating plans for the coming periods; 2. formalizes management’s plans in quantitative terms; 3. forces all levels of management to think ahead, anticipate results, and take action to remedy possible poor results; and 4. may motivate individuals to strive to achieve stated goals. TYPES OF BUDGETS Companies, nonprofit organizations, and governmental units use many different types of budgets. Responsibility budgets are designed to judge the performance of an individual segment or manager. Capital budgets evaluate long-term capital projects such as the addition of equipment or the relocation of a plant. This lecture examines the master budget, which consists of a planned operating budget and a financial budget. The operating budget helps to plan future earnings and results in a projected income statement. The financial budget helps management plan the financing of assets and results in a projected balance sheet. MANAGEMENT’S ASSUMPTIONS ABOUT BUDGETS A budget should describe management’s assumptions relating to: 1. the state of the economy over the planning horizon; 2. plans for adding, deleting, or changing product lines; 3. the nature of the industry’s competition; and 4. the effects of existing or possible government regulations. If these assumptions change during the budget period, management should analyze the effects of the changes and include this in an evaluation of performance based on actual results. BENEFITS OF THE PREPARATION OF BUDGETS Many 1. 2. 3. 4. 5.

other benefits result from the preparation and use of budgets. For example: businesses can better coordinate their activities; managers become aware of other managers’ plans; employees become more cost conscious and try to conserve resources; the company reviews its organization plan and changes it when necessary; and managers foster a vision that otherwise might not be developed.

BUDGETING PROCESS Budgeting involves the coordination of financial and nonfinancial planning to satisfy organizational goals and objectives. No foolproof method exists for preparing an effective budget. The budgeting process involves planning for future profitability because earning a reasonable return on resources used is a primary company objective. A company must devise some method to deal with the uncertainty of the future. A company that does no planning whatsoever chooses to deal with the future by default and can react to events only as they occur. Most businesses, however, devise a blueprint for the actions they will take given the foreseeable events that may occur. BUDGETING CYCLE 1. Performance planning 2. Provide a frame of reference 3. Investigate variations 4. Corrective action 5. Planning again - take into account feedback.

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ADVANTAGES OF BUDGETING  Define goals and objectives  Think about and plan for the future  Means of allocating Resources  Coordinate activities  Communicate plans SELF-IMPOSED OR PARTICIPATORY BUDGETING Participatory budgeting means that all levels of management responsible for actual performance actively participate in setting operating goals for the coming period. ADVANTAGES OF PARTICIPATORY BUDGETING 1. Individuals at all levels of the organization are viewed as members of the team whose judgments are valued by top management. 2. Budget estimates prepared by front-line managers are often more accurate than estimates prepared by top managers. 3. Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above. 4. A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Self-imposed budgets eliminate this excuse. MASTER BUDGET The master budget expresses management’s operating and financial plans for a specified period, and it includes a set of budgeted financial statements. The master budget is the initial plan of what the company intends to accomplish in the budget period.

OPERATING BUDGETS The operating budget is actually composed of eight supporting budget planning schedules. They are interrelated and come together to develop a budgeted income statement based on the operating budget. COMPONENTS OF OPERATING BUDGETS 1. Sales Budget  Expected Cash Collections 2. Production Budget 3. Direct Materials Budget  Expected Cash Disbursement for Materials 4. Direct Labor Budget 5. Manufacturing or Factory Overhead Budget 6. Ending Finished Goods Inventory Budget 7. Selling and Administrative Expense Budget 8. Budgeted Income Statement FINANCIAL BUDGETS The financial budget represents a summation of anticipated receipts and disbursements for the budget period. Its purpose is to plan for the allocation of working capital as represented by the current assets of the enterprise. It indicates the need of capital at various times and helps the management in planning and providing the proper quantity of cash to meet the needs of the business. It provides information of the probable profits to be realized during the budget period and helps the management in making the long-term plans.

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COMPONENTS OF FINANCIAL BUDGETS 1. Cash Budgets 2. Capital Expenditure Budgets 3. Budgeted Statement of Financial Position/Balance Sheet 4 Sections of Cash Budget The cash budget is divided into four sections: 1. Cash receipts section lists all cash inflows excluding cash received from financing; 2. Cash disbursements section consists of all cash payments excluding repayments of principal and interest; 3. Cash excess or deficiency section determines if the company will need to borrow money or if it will be able to repay funds previously borrowed; and 4. Financing section details the borrowings and repayments projected to take place during the budget period. ILLUSTRATIVE EXAMPLE SALES BUDGET  Laberboi Company is preparing budgets for the quarter ending June 30th.  Budgeted sales for the next five months are: - April: 20,000 units - May: 50,000 units - June: 30,000 units - July: 25,000 units - August: 15,000 units  The selling price is ₱100 per unit. April Budgeted sales in units

May

20,000

50,000

June 30,000

Quarter 100,000

Selling price per unit Total budgeted sales EXPECTED CASH COLLECTIONS  All sales are on account.  Laberboi’s collection pattern is: - 70% collected in the month of sale, - 30% collected in the month following sale,  In April, the March 31st accounts receivable balance of ₱300,000 will be collected in full in April. April Accounts Receivable 3/31

May

June

₱ 300,000

Quarter ₱ 300,000

April Sales

May Sales

June Sales TOTAL PRODUCTION BUDGET  The management at Laberboi Company wants ending inventory to be equal to 20% of the following month’s budgeted sales in units.  On March 31st, 4,000 units were on hand.

Budgeted Sales

April

May

June

Quarter

20,000

50,000

30,000

100,000

Add: Desired ending inventory

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Total needs Less Beginning inventory Required production DIRECT MATERIALS BUDGET • At Laberboi Company, five pounds of material are required per unit of product. • Management wants materials on hand at the end of each month equal to 10% of the following month’s production. • On March 31, 13,000 pounds of material are on hand. Material cost is ₱4.00 per pound. April

May

June

Quarter

Production Materials per unit (pounds) Production needs Add: Desired ending inventory Total needed Less: Beginning inventory Materials to be purchased EXPECTED CASH DISBURSEMENT FOR MATERIALS • Laberboi pays ₱4.00 per pound for its materials. • One-half of a month’s purchases is paid for in the month of purchase; the other half is paid in the following month. • The March 31 accounts payable balance is ₱120,000. April Accounts payable 3/31

May

June

₱ 120,000

Quarter ₱ 120,000

April purchases

May purchases

June purchases

Total cash disbursements

DIRECT LABOR BUDGET • At Laberboi, each unit of product requires 0.05 hours (3 minutes) of direct labor. The labor can be unskilled because the production process is relatively simple and formal training is not required. • Laberboi pays its workers at the rate of ₱100.00 per hour. April

May

June

Quarter

Units of production Direct labor time per unit Labor hours required Hourly wage rate Total direct labor costs

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MANUFACTURING OVERHEAD BUDGET • At Laberboi, manufacturing overhead is applied to units of product on the basis of direct labor hours. • The variable manufacturing overhead rate is ₱200 per direct labor hour. • Fixed manufacturing overhead is ₱500,000 per month, which includes ₱200,000 of noncash costs (primarily depreciation of plant assets). April

May

June

Quarter

Budgeted direct labor hours Variable mfg. OH Rate Variable mfg. OH costs Fixed mfg. OH costs Total mfg. OH costs Less: noncash costs Cash disbursement for mfg. OH ENDING FINISHED GOODS INVENTORY BUDGET Production costs per unit

Quantity

Direct materials

5.00 lbs.

Direct labor

0.05 hrs.

Manufacturing overhead

0.05 hrs.

Cost

₱

Total

₱ 4.00

₱ 2.00

100.00

0.50

Budgeted finished goods inventory Ending inventory in units Unit product cost Ending finished goods inventory SELLING AND ADMINISTRATIVE EXPENSE BUDGET • At Laberboi, the selling and administrative expense budget is divided into variable and fixed components. • The variable selling and administrative expenses are ₱5.00 per unit sold. • Fixed selling and administrative expenses are ₱700,000 per month. • The fixed selling and administrative expenses include ₱100,000 in costs – primarily depreciation – that are not cash outflows of the current month. April Budgeted sales

20,000

May 50,000

June 30,000

Quarter 100,000

Variable S&A rate Variable expenses Fixed S&A expenses Total S&A expenses Less: noncash expenses Cash S&A expenses CASH BUDGET • Assume the following information for Laberboi: – Maintains a 16% open line of credit for ₱750,000. – Maintains a minimum cash balance of ₱300,000. – Borrows on the first day of the month and repays loans on the last day of the month.

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– – –

Pays a cash dividend of ₱490,000 in April. Purchases ₱1,437,000 of equipment in May and ₱483,000 in June (both purchases paid in cash). Has an April 1 cash balance of ₱400,000. April

Beginning cash balance

May

June

Quarter

₱ 400,000

Add: Cash collections Total cash available Less: Cash disbursements Materials Direct labor Manufacturing overhead Selling and administrative Equipment purchase Dividend Total disbursements Excess (deficiency) Financing: Borrowing Repayment Interest Total financing Ending cash balance BUDGETED INCOME STATEMENT LABERBOI COMPANY Budgeted Income Statement For the Three Months ended June 30 Sales (100,000 units x ₱100.00) Cost of Goods Sold Gross Margin Selling and Administrative Expense Operating Income Interest Expense Net Income BUDGETED BALANCE SHEET • Royal reported the following account balances prior to preparing its budgeted financial statements: – Land - ₱500,000 – Common stock -₱1,500,000 – Retained earnings - ₱2,481,250 (April 1) – Equipment - ₱1,750,000 • 30% of June sales of ₱3,000,000. • 11,500 lbs. at ₱4.00/lb. • 5,000 units at ₱49.90 each. • 50% of June purchases of ₱568,000. LABERBOI COMPANY Budgeted Balance Sheet As of June 30, 2019 ASSETS Cash Accounts Receivable Raw Materials Inventory Finished Goods Inventory

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